If you’re in the market for a home and want to start investing in real estate, you may want to consider a strategy known as “house hacking.”
What’s involved in house hacking? It’s simple: You buy a multifamily property and live in one of the units while renting out the other(s) to generate income.
This is a great way to make your own housing payment much lower (or even free). It also builds equity and gives you valuable experience to carry over to other real estate investments.
Here’s a rundown of what house hacking is and what you need to know before deciding if it’s right for you.
One of the best ways to start investing in real estate is to buy a multifamily property and live in one of the units while renting the others.
(Note: a multifamily property is any building with two to four units.)
You’ll get some of the benefits of homeownership as well as some of the benefits of being a landlord. We’ll get into the specific benefits a little later. The point is this lets you own a home and build equity with little money out of your own pocket.
Before we get deeper into the discussion, here’s my story. I now own stand-alone rental properties, but that’s not how my real estate investing started.
When I was in my mid-20s, my then-fiance (now wife) and I were living in the Florida Keys. Real estate isn’t cheap down there. As a teacher and a nurse, we were having difficulty finding any decent homes we could afford to rent or buy.
My real estate agent made a suggestion: Buy a property with two living units. Live in one side and rent out the other. We bought a home with a two-bedroom main living area and a separate one-bedroom apartment attached to it.
Here’s why this worked to our benefit. We didn’t need a ton of space, so we didn’t mind a smaller living area for ourselves. We rented the apartment out for $1,100 per month — very cheap for a one-bedroom apartment in the Florida Keys. We used this income to pay nearly half of our monthly mortgage payment. We ended up living in a nice house for $500 less per month than it would have cost us to rent or buy a comparably sized two-bedroom condo or apartment.
Keep in mind that this was a small-scale version of house hacking. The rented portion of our house was less than one-third of its square footage. If you buy a duplex, triplex, or quadruplex, your rental income could cover your entire mortgage or more.
Note that residential properties with five or more units are classified as commercial real estate. So they can’t be treated as your personal residence for mortgage purposes.
Buying a multifamily home to live in and rent out has some compelling benefits. It might even be better than buying a single-family house to live in or a stand-alone investment property to rent.
The most obvious benefit is that it makes your housing payment lower or even erases it altogether. For example, if you buy a triplex with a mortgage payment of $1,800 per month and you collect $800 in monthly rent from the other two units, your out-of-pocket housing payment drops to $200. Alternatively, you can use the rent money you collect to pay down your mortgage even faster.
You also get the advantage of primary residence financing. It’s usually much cheaper to finance a primary home. You’ll get a lower interest rate and lower fees than you’d get for an investment property loan.
And you can probably buy with a significantly lower down payment. Most investment property lenders want at least 20% down. Meanwhile, you can get a conventional primary residence mortgage with as little as 3% down — or qualify for FHA financing with 3.5% down if you have a limited credit history. If you’re a veteran or active-duty military, you may be able to get a 0%-down VA mortgage.
Buying a multifamily home instead of a single-family residence also lets you build equity faster — and on someone else’s dime. For example, if you can spend $400,000 buying a triplex or $200,000 buying a single-family home, making your monthly mortgage payments on the triplex will build equity twice as fast.
This strategy also lets you learn the ins and outs of real estate investing in an easier and more forgiving way than buying a stand-alone rental property. You live on the property, so it’s easier to identify and deal with problems than if you lived elsewhere.
Having gone through those advantages, it’s important to point out that house hacking isn’t for everyone. Here are a few potential drawbacks to consider before deciding if it’s right for you:
First and foremost, house hacking is a real estate investment and shouldn’t be taken lightly. Familiarize yourself with the basics of owning and operating rental properties before you get started.
Second, there’s considerable risk and headaches involved with being a landlord. It’s unrealistic to assume that your tenant interactions are going to be smooth sailing. Tenants don’t often treat rental properties with the same level of respect as they’d treat a home they owned. So there could be considerable (and uncertain) maintenance expenses.
Plus, there’s the risk that one or more of your rentable units will sit vacant for a period of time. And it can be rather unpleasant to deal with situations like late rent and evictions if you live right next door.
Third, the tax implications of rental income are complex, especially when a property is in the grey area between an investment property and a primary residence. At a minimum, you should know how taxes work on rental income and seek the advice of a tax professional to help you navigate the process. Taxes work differently for investment properties than they do for primary residences. And you’ll have to use both on a percentage-use basis.
Finally, there’s a degree of privacy and freedom you give up by living in a multifamily home. There’s value in having your own yard and not having to worry about noise from your neighbors. Be sure to consider your own comfort before you buy a multifamily home.
Purchasing a multifamily home to live in and rent out the other units can be a great way to kickstart your real estate investment strategy. And it can help you build wealth over time faster than you otherwise could.
Having said that, living in a multifamily home and being someone else’s landlord isn’t right for everybody. Consider the advantages as well as the drawbacks before you decide to move forward.